FCOT: Distribution Reinvestment Plan (DRP).

Received another DRP offer and this time it is from Frasers Commercial Trust (FCOT). This is probably not going to see any take up because the price of $1.2389 per new unit to be allotted is higher than what we could get from Mr. Market now which is $1.235 per unit.

It is probably good to be reminded that the headwinds for REITs could get stronger and if we want to invest in REITs, we have to recognise this. One of these headwinds is an environment of rising interest rates.

So, the DRPs which S-REITs are pushing out now make sense because, if taken up, they will lead to lower gearing levels. The REITs could pay down their debt with the funds as well when they fall due. This is probably a good thing for unit holders too.

To me, it only makes sense to take part in DRPs if we want to increase our long positions in the REITs concerned. However, with rising risk free rates, unit prices of S-REITs will continue to experience downward pressure, everything else remaining equal. So, to me, it doesn't seem very prudent to take part in DRPs at this point in time or in the near future.

I am not against others taking part in the DRPs to strengthen the balance sheets of the S-REITs I am invested in, however. In the meantime, I am quite happy to continue receiving income from these S-REITs and possibly increasing my investments in them only when Mr. Market makes offers too attractive to ignore.

Related posts:
1. Distribution Reinvestment Plan: First REIT and CIT.
2. AIMS AMP Capital Industrial REIT: DRP.

CapitaMall Trust: Buy the retail bond or the REIT?

CapitaMall Trust is offering $200 million worth of bonds. They will mature 7 years later in 2021 and will have a coupon of 3.08%. Is this a good thing?

Well, as the REIT has quite a bit of debt due for repayment this year, this fund raising effort is necessary and timely. The coupon of 3.08% is also lower than their average cost of debt of 3.4% as at 31 Dec 2013. So, this is a good thing for unit holders of the REIT. DPU won't be negatively affected.

As S$150 million of the retail bonds will be offered to the public with the minimum investment sum set at only $2,000, it is within reach of regular retail investors like you and me. If we look at this as a kind of forced savings, a pseudo-CPF if you will, and hold it for the full 7 years period, I think it is not that bad a proposition. Why?

Well, if we hold it for the full 7 years, we won't suffer any capital loss which could happen if we decide to sell before maturity.

You mean we might lose money if we cannot hold for the full 7 years? Yes, possibly, especially with expectations that interest rates will continue rising.

So, if the risk free rate should rise by 1%, investors might expect a 4.08% return from this instead of the 3.08% being offered now, for example. The bond price would have to fall in order to offer this higher return. How much must the bond price fall to give this return? Approximately 25%.

Pause.

Pause.

Pause.

Yes, 25%. The good news is that if we were to hold to maturity, then, we are safe. So, what to do? We buy the bond with money we don't need for the next 7 years. We will get back our principal when the 7 years is up, well, if CMT doesn't go belly up. (See comments by Charlie and AK71 in the comments section below.)

So, this retail bond offering could benefit anyone investing for income in two ways. Invest in the REIT for a distribution yield of 5.64% (unit price of $1.815 at closing) or to buy the bond for a coupon of 3.08% over the next 7 years.

Wah! AK71 so silly. Of course, invest in the REIT. The yield is so much higher! Well, remember that REITs are leveraged investments. Without the gearing of about 35%, the distribution yield wouldn't be so much higher and would be closer to 3.75%. Gearing is a fantastic thing, isn't it?

Wait a minute, 3.75% is still higher than 3.08%. So, investing in the REIT is still a better choice. Indeed, it seems to be the case and that would be my preference too.

Remember that this analysis has taken place in a vacuum, totally ignoring other factors which could have a bearing on the performance of the REIT or the retail bond. However, comparing the two options thus gives us a clearer picture of which option an investor for income might want to lean towards.

Read: CapitaMall Trust launches retail bond offering.

Related post:
Saizen REIT: Risk free rate and unit price.